San Jose Retirement at 50 Threatens Solvency: Muni Credit

By Alison Vekshin and James Nash -
May 1, 2012

Police officers and firefighters in
San Jose, California, can retire at age 50 with 90 percent of
their pay. The deal has left Silicon Valley’s capital so short
of cash that a library and community center has stood unused
since its completion two years ago.

The predicament of the 10th-biggest U.S. city reflects the
painful choices that rising public-worker pension and health
costs are inflicting on municipalities. In San Jose, the burden
has become a $2.7 billion unfunded liability, costing the city
its AAA bond rating. Next month, voters will decide on a measure
that would trim the city’s payments for its two pensions.

“Our police officers and firefighters will probably make
more money in retirement than they did while they were
working,” Mayor Chuck Reed, 63, said in an interview last week
in his City Hall office. “We’re seeing the impacts of that on
our ability to provide services.”

From California to Rhode Island, local governments are
trying to curb retirement costs that are straining budgets
almost three years after the end of the longest recession since
the 1930s. Illinois Governor Pat Quinn proposed last month that
public employees pay more for pensions. Forty-one states have
reduced benefits or raised contributions, according to the
National Association of State Budget Officers.

Technology Hometown

San Jose, hometown of Cisco Systems Inc. (CSCO), the biggest maker
of computer-networking equipment, is looking to cut pension and
retiree-health benefits approved during more robust economic
times. The city of about 960,000 has two plans, one for safety
personnel and one for civilians, covering about 4,700 retirees.

Police and fire personnel can retire and tap pension
benefits at age 50 with 25 years of service, or at any age if
they’ve worked 30 years, earning a maximum of 90 percent of
final compensation, according to the city auditor. The median
retirement age was 54 as of June 2009. Police and firefighters
who retired since 2006 receive an average pension of about
$103,000, including cost-of-living increases, according to the
city.

Reed, a lawyer who served in the Air Force, attributes the
benefits growth to a combination of confidence among lawmakers
that stocks would appreciate, friendly relations between union
leaders and City Council members and unions seeking changes
granted to other cities.

“We’re competing” with other pension plans, Reed said.
“It’s a leapfrog, and the unions used that very effectively in
arguing for increased benefits.”

Benefit Boost

When San Jose’s pension benefits were established in 1961,
police and firefighters could retire at 55 and, with 20 years of
service, receive a pension of half of final compensation,
according to the city auditor. In 1984, the City Council agreed
to give employees and their families health care for life after
15 years of service.

The region’s economy flourished during the dot-com boom,
and in 1998 the benefit was raised from 75 percent to 80 percent
of final pay.

In 2002, police and fire retirees got a guaranteed annual
increase and a so-called 13th paycheck when plan earnings beat
expectations. Civilian employees got the extra payment in 1986
and the yearly boost in 2006.

Jim Spence, president of the Association of Retired San
Jose Police Officers & Firefighters, said the pay and benefit
levels are needed to recruit employees.

“They did a dangerous job and the reward for that job is
they would get a decent pension,” Spence said in a telephone
interview.

“I’m not going to apologize for the fact that I have a
good retirement benefit because that’s something that we
negotiated for,” he said. “That’s something we worked for.”

Costs Triple

Reed, who moved to San Jose in 1978, ran for mayor in 2006
after six years as a council member with the goal of fixing the
city’s budget deficit and curbing spending.

Retirement costs have climbed to $245 million this fiscal
year from $73 million a decade ago. In the same period, the
workforce dropped 28 percent to 5,400, according to the mayor.

Reed said he began to view pension costs as a threat when
he saw a chart projecting obligations would escalate to $400
million in 2016.

“We started realizing we have to cut pay, we have to cut
benefits, we can’t continue on this,” he said.

Last year, Reed floated the idea of declaring a fiscal
emergency, which he said would have allowed him to require
concessions from employees. The same move was tried for three
straight years in Stockton, California, an agricultural center
about an hour’s drive away.

Stockton’s Mediation

Stockton defaulted this year on $2 million in bond payments
and entered mediation with creditors. A new state law requires
the talks before a municipality can seek Chapter 9 bankruptcy
protection.

California has already been home to two of the largest U.S.
municipal bankruptcies: Orange County, which filed in 1994 after
losing $1.7 billion on investments; and Vallejo, in 2008, after
failing to win union concessions.

Mammoth Lakes, a ski resort community of 8,200 near
Yosemite National Park, lost a lawsuit with a developer and
faces a judgment more than twice the size of its annual
operating budget. Hercules, a town of 24,000 near San Francisco,
is saddled with debt from the state’s elimination of
redevelopment agencies, as are Milpitas with about 67,000
people, and Poway, with about 48,000.

Boom and Bust

Lincoln, a Sacramento suburb of 43,000, and Chowchilla, a
town of close to 19,000, saw their populations soar in the
housing boom before real-estate taxes evaporated in the bust.

“We’re struggling to live within our means,” said Anna
Jatczak, assistant city manager of Lincoln, where the 2011-2012
budget is 65 percent lower than four years earlier. “Everyone
in California is dealing with this in one way or another.”

In March, San Jose’s City Council voted to place a measure
on the June ballot that would require new hires to contribute 50
percent toward their retirement plan.

The city expects a $9 million surplus in fiscal 2013 and a
$22 million deficit the following year, Jennifer Maguire, the
budget director, said in an April 25 interview.

Since March 2011, Fitch Ratings, Moody’s Investors Service
and Standard & Poor’s have cut the city’s general-obligation
ratings to the second-highest grade.

‘Arduous Barriers’

The city’s leadership is “being significantly challenged
to manage retirement costs and faces arduous barriers to reduce
the impact of those obligations,” Moody’s said in a statement
announcing the March downgrade.

Investors in San Jose debt are unfazed by the fiscal
strains, in part because a dearth of sales by California issuers
has bolstered demand.

A tax-exempt San Jose general-obligation bond maturing in
September 2022 traded with an average yield of 1.14 percent on
April 26, or 0.77 percentage point below a BVAL benchmark of
top-rated debt. In December, the bond traded with an average
yield as high as 2.84 percent, almost a percentage point above
the AAA bond.

San Jose’s 40,000-square-foot Bascom Library and Community
Center, empty since 2010, was paid for out of proceeds of a $212
million bond voters approved in 2000. Three other libraries and
a police substation, all newly built, are also unused.

Fiscal Emergency

On top of trimming pension costs, the mayor’s plan would
also give the City Council authority to temporarily suspend
annual pension increases during a fiscal emergency. It
eliminates the extra paycheck and voters would approve any
future benefit increase.

“We are already in a position where services are
substandard,” Reed said. If the measure fails, the city will be
a year away from a “service-level insolvency,” meaning it will
have money to pay its bills only by cutting services, he said.

Reed, whose term expires in 2014, said the pension issue
will define his tenure as mayor.

“Failure is not an option, because it will result in
really bad things happening to the people of San Jose,” he
said. “My job is to avoid that, to look ahead to the future and
to take the steps necessary to avoid a disaster.”

Following are pending deals:

OHIO HIGHER EDUCATIONAL FACILITY COMMISSION is set to issue
$175 million of revenue bonds as soon as tomorrow on behalf of
the University Hospitals Health System. Banc of America Merrill
Lynch is the underwriter. Moody’s rates the deal A2, sixth-
highest. (Added May 1)

DISTRICT OF COLUMBIA plans to sell $329 million in revenue
bonds as soon as this week. The debt, backed by the district’s
income taxes, will be used for refunding, according to data
compiled by Bloomberg. S&P rates the bonds AAA, its top grade.
(Added April 30)

LOS ANGELES plans to issue $300 million in wastewater
revenue bonds as soon as this week, according to an offering
document. The debt will be used for refunding and divided
between senior lien bonds and subordinate bonds. (Added April
30)